Selling A Piece Of The Federal Reserve

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There is growing concern about where the Fed will get the hundreds of billions of dollars it will need to bail-out failing banks and brokerages. Most economists point to the tax-payer as the ultimate source, either through inflation or minting new money. All of its works its way back to John Q. Public.

Over at Treasury, Paulson has been beating the daylights out of sovereign funds to get them to agree to put money into US companies only if the reasons for the investments are purely financial. No political agenda allowed. Most of the funds from the Middle East, China, and Singapore have already left the building. The risks of putting more cash into US financial firms has become to great. Many of the big pools of capital have already lost a lot of money on investments in Blackstone (NYSE: BX), Citigroup (NYSE: C), and Merrill Lynch (NYSE: MER). Better for sovereign funds to put capital into coffee plantations in Honduras.

Paulson and the Fed could get the sovereign funds back into the market. Instead of the US government putting up all of the money for fixing the banking system it might ask the big overseas funds to put capital into financial companies side-by-side with the central bank. That would take a little pressure off the system.

A good example of how this might work is that Abu Dhabi could put up a piece of the $30 billion for JP Morgan’s (NYSE: JPM) buyout of Bear Stearns (NYSE: BSC) Instead of the US government guaranteeing all of that, perhaps it would back $15 billion. Let the sovereign fund take a partial risk for putting in the first tranche of capital and let it get the first reward if the deal works.

Sovereign funds may have pulled out of the US. Investing side-by-side with the Fed might get them back and it could save taxpayers a few dollars down the road.

Douglas A. McIntyre